E A S T M A N C H E M I C A L C O M PA N Y 2 0 0 5 A N N U A L R E P O R T
Eastman Chemical Company manufactures and markets chemicals, fibers and plastics
     worldwide. It provides key different...
At Eastman, we see the face of opportunity everywhere. In innovation,
leadership, possibility, collaboration and in caring...
TO O U R STO C K H O L D E R S




                                                        From strengthening our global m...
J. Brian Ferguson
               Chairman and Chief Executive Officer




Let me elaborate on each of these four points.  ...
F O C U S E D G R O W T H S T R AT E G Y We have    and occupy half the footprint of conventional
great confidence in the ...
Eastman’s management team has a

                               track record of financial discipline, and

               ...
E A S T M A N AT- A - G L A N C E


                                C O AT I N G S , A D H E S I V E S ,
                 ...
Packaging                43.99%                Durables                       4.81%
                                      ...
quot;I embarrass my wife in supermarkets because I’m always picking up

                                                  ...
THE FACE OF INNOVATION




It takes a combination of detective work, psychology and science to develop innovations that fu...
THE FACE OF LEADERSHIP




The key to our market-leading standing is neither simply our size nor our longevity; it’s both
...
“I believe Eastman’s success comes from taking calculated risks in areas

                     we know and have capabiliti...
“Working on chemicals from coal has been, and will always be, the

                                  highlight of my caree...
THE FACE OF POSSIBILITY




“What if…?” These two little words have led to some amazing transformations at Eastman. By
con...
THE FACE OF COLLABORATION




Eastman is more than a supplier; we’re a partner. We want our customers, and their customers...
Brazilian cosmetic company Natura chose Eastman’s The Glass Polymer copolyester for several packaging

applications. “We a...
THE FACE OF CARING




 Throughout our 86-year history, one constant has been our culture of caring. We live this value
 e...
UNITED STATES
                           SECURITIES AND EXCHANGE COMMISSION
                                           WAS...
Yes   No
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the       [X]...
These plans and expectations are based upon certain underlying assumptions, including those mentioned with the
specific st...
TABLE OF CONTENTS

ITEM                                                                     PAGE
                         ...
PART I
ITEM 1. BUSINESS
CORPORATE OVERVIEW

History, Business, and Recent Results

Eastman Chemical Company (quot;Eastmanq...
The following chart shows markets and significant Eastman products by segment and manufacturing stream.

         SEGMENTS...
EASTMAN DIVISION

Business and Industry Overview

Operating in a variety of markets with varying growth prospects and comp...
Institutionalizing cost reduction processes, including a Six Sigma quality improvement program aimed at
         reducing ...
Adhesives Raw Materials
         The adhesives product line consists of hydrocarbon resins, rosin resins, resin dispersion...
•   Customers and Markets

As a result of the variety of end uses for its products, the customer base in the CASPI segment...
PCI also manufactures complex organic molecules such as diketene derivatives, specialty ketones, and specialty
anhydrides ...
•   Competition

Historically, there have been significant barriers to entry for competitors with respect to a majority of...
•   Products

The SP segment’s key products are:

          Engineering and Specialty Polymers
    Engineering and special...
Packaging, Film and Fiber
    Packaging, film and fiber products, which represented approximately 20 percent of the SP seg...
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  1. 1. E A S T M A N C H E M I C A L C O M PA N Y 2 0 0 5 A N N U A L R E P O R T
  2. 2. Eastman Chemical Company manufactures and markets chemicals, fibers and plastics worldwide. It provides key differentiated coatings, adhesives and specialty plastics products; is the world’s largest producer of PET polymers for packaging; and is a major supplier of cellulose acetate fibers. Founded in 1920 and headquartered in Kingsport, Tenn., Eastman is a FORTUNE 500 company with 2005 sales of $7 billion and approximately 12,000 employees. Eastman is listed on the New York Stock Exchange, and its shares trade under the symbol EMN. For more information about Eastman and its products, visit www.eastman.com. FINANCIAL HIGHLIGHTS 2005 2004 Change Dollars in millions, except per share amounts Operating Results Sales $7,059 $6,580 7% Gross profit 1,404 978 44% Operating earnings 757 175 >100% Net earnings 557 170 >100% Net earnings per share Basic 6.90 2.20 >100% Diluted 6.81 2.18 >100% Cash dividends per share 1.76 1.76 – Other Financial Data Impairments and restructuring charges, net 33 206 84% Other operating income (2) (7) (71)% Net cash provided by operating activities 769 494 56% Capital expenditures 343 248 38% Depreciation and amortization expense 304 322 (6)% Selling, general and administrative expense 454 450 1% Research and development costs $ 162 $ 154 5% Front cover (left to right): Tony Foreman, Procurement Engineer; Gustavo Gouvea, Six Sigma Black Belt; Beat Zueger Regional Business Director, Fibers; Heather Smoot, Market Insight and Strategy Specialist Facing page (left to right): Suzanne Dobbs, Technologist, Technical Services; Deep Bhattacharya, Principal Research Chemist; James Ray, Vice President and General Manager, Texas Operations Back cover: Rhonda Williams, Operator, Gasification Department
  3. 3. At Eastman, we see the face of opportunity everywhere. In innovation, leadership, possibility, collaboration and in caring about our local communities. That’s why you’ll see the faces of Eastman throughout these pages. They and their 12,000 colleagues around the world turn opportunity into reality on a daily basis. They are the face of Eastman – and so much more. In their heads is the knowledge to create market value out of molecules. In their hearts is the passion to build customer loyalty for products that are brand new. In their imagination is the vision to deliver pioneering products. And in their hands is the capability and commitment to make positive contributions where they live and work. Eastman people bring their whole selves to the job every day. And that’s why we are facing the future with confidence.
  4. 4. TO O U R STO C K H O L D E R S From strengthening our global manufacturing structure, to permanently reducing costs, to making strategic divestitures, we have made important changes throughout the Company. 2005 was a year of significant accomplishment were exacerbated by the hurricanes that for Eastman. But it didn’t happen by chance. devastated the Gulf Coast. I am proud of our From strengthening our global manufacturing employees and business partners who quickly structure, to permanently reducing costs, to responded to these natural disasters and making strategic divestitures, we have made demonstrated incredible ingenuity to mitigate important changes throughout the Company. the subsequent supply chain disruptions. As a result, we not only surpassed our goals, Their performance was truly remarkable. we set new records. CONTINUING TO DELIVER ON • Earnings per share were the best in ten years. C O M M I T M E N T S You’ll recall that last year • Sales revenue of $7 billion was the best in the we pledged to improve our performance, Company’s history and reflects gains across strengthen our balance sheet and grow our virtually all parts of the Company. earnings. As our 2005 results showed, we • Gross profit increased by over $400 million, delivered on each of these commitments, and gross margins improved to approximately and I’m confident we can build on our success 20 percent. through continued focus and dedication. My • Return on invested capital (ROIC) improved confidence is supported by Eastman’s: 12 percentage points over 2004 levels, reach- ing in excess of 19 percent for the year. • Solid base of businesses that provides • Cash flow remained strong, enabling us to strong, steady financial performance; further strengthen Eastman’s balance sheet, • Strategic plans to strengthen areas of the fund the Company’s U.S. defined benefit Company that are more affected by cyclicality; pension plans, support strategic growth • Focused growth strategy that leverages our initiatives and reward our stockholders by unique technologies and advantaged cost maintaining a solid dividend. position to deliver unique greener, smarter, lower-cost value propositions, and; These results are particularly notable given the • Track record of financial discipline which volatility in raw material and energy costs which ensures we create – not consume – value for our stockholders. 02 E A S T M A N C H E M I C A L C O M PA N Y
  5. 5. J. Brian Ferguson Chairman and Chief Executive Officer Let me elaborate on each of these four points. our focus is on increasing the value creation throughout our PET (polyethylene terephthalate) S O L I D B A S E O F B U S I N E S S E S With a businesses, and though we are in the early combined 2005 operating margin of over stages, we are taking strategic actions to 17 percent, Eastman’s CASPI (Coatings, accomplish this. Adhesives, Specialty Polymers and Inks), Fibers and Specialty Plastics segments provide Additionally, we expect our new low-cost and energy-efficient IntegRex technology to drive a solid base of earnings. In the aggregate, these three businesses contributed $500 million, or further value, particularly in our North American nearly two thirds, of Eastman’s operating earn- PET businesses. Without question, PET is a tough ings in 2005. These businesses have a history of commodities business. Our vertically integrated solid and steady performance, largely because PET facilities, however, have consistently demon- of their differentiated product lines and unique strated profitability, with those in North America market or cost positions. earning above the cost of capital five out of the past six years. IntegRex plays an important part in our ongoing efforts to strengthen our cost S T R AT E G I C P L A N S T O S T R E N G T H E N A R E A S O F T H E C O M PA N Y Our Performance position in our PET line of products. Our first Chemicals and Intermediates (PCI) and Polymers facility using this technology is expected to come businesses are important to Eastman, but on-line in the fourth quarter of this year and be because they compete primarily on price, they fully operational during the first quarter of 2007. are more affected by industry cycles. Our goal is With this new 350,000-metric-ton PET manufac- to reduce the cyclicality and increase the prof- turing plant, which is being built at our site in itability of these segments through a number Columbia, South Carolina, Eastman will have of strategic portfolio management efforts. We the lowest conversion cost and lowest capital expect to make measurable progress on efforts per pound of product for any PET process in already underway in PCI. In Polymers, much of North America. E A S T M A N C H E M I C A L C O M PA N Y 03
  6. 6. F O C U S E D G R O W T H S T R AT E G Y We have and occupy half the footprint of conventional great confidence in the strength of our existing PET plants. This facility is expected to come businesses, yet we also understand that a strat- on-line later this year, and as that happens, egy to drive long-term growth is important if we we’ll share more about our plans to use are to achieve our goals. Accordingly, we further rationalized PET assets to scale-up our unique, refined a growth strategy last year that is high-performance copolyester product lines. concentrated on a select set of initiatives that, when layered onto our existing strong base of In our Fibers business, we’re exploring options earnings, we believe will enable us to reach a for acetate tow capacity expansions in Europe new level of success and value creation. and Asia that would allow us to leverage our advantaged raw material position in this busi- These initiatives target growth opportunities ness to meet projected annual increases in in markets we know well, and where we have global demand. Another initiative in the early a strong customer base. Additionally, as I stages of development is one we call “chemicals explained to you in my letter last year, they from coal.” Through this effort, we are working have the common theme of “greener, smarter, to build on our unique expertise in coal gasi- lower-cost” running through them. Consumers fication, the cleanest coal technology, and in look for products that have some combination producing low-cost commodity chemicals. of being environmentally responsible, high You can expect to hear more about our progress performance and economical. Our customers on these and other growth initiatives later in are no different. Through our unique technolo- the year. gies and cost advantages, we are positioned to deliver on this value proposition. TRACK RECORD OF FINANCIAL DISCIPLINE Eastman’s management team has a track record An example of this is the previously mentioned of financial discipline, and we intend to maintain IntegRex PET facility, which will use less energy that discipline as we fund growth in 2006. 04 E A S T M A N C H E M I C A L C O M PA N Y
  7. 7. Eastman’s management team has a track record of financial discipline, and we intend to maintain that discipline as we fund growth in 2006. I strongly believe in the long-term earnings disciplined way. This, along with our team of the potential of our growth initiatives. Investing most dedicated and knowledgeable people in in them is a priority for cash in the coming the business, gives me confidence that Eastman year. We will diligently monitor our progress is poised to continue meeting its goals. in these initiatives to ensure that we – and you – are getting a sound return on our invest- But don’t just take my word for it. There ment. Additionally, Eastman’s dividend will are 12,000 faces at Eastman that share my remain a top priority – just as it has for the enthusiasm. All of us look forward to making past 48 straight quarters. the most of the opportunities we have created for ourselves and to proving that we have Our financial objectives continue to be main- what it takes to create long and lasting value taining an operating margin above 10 percent, for all of our stakeholders. growing volume above GDP and delivering a value-creating spread above the cost of capital. Sincerely, FACING THE FUTURE WITH CONFIDENCE Today Eastman is a stronger, more focused company. We have a solid foundation of earn- ings generated by financially sound, steady J. Brian Ferguson businesses. We have plans and are taking Chairman and Chief Executive Officer actions to strengthen the more cyclical areas of the Company. We are committed to a strategy that builds on Eastman’s unique technologies and cost position to deliver a greener, smarter, lower-cost value proposition for our customers and profitable growth for our stockholders. And we pledge to pursue this growth in a smart, E A S T M A N C H E M I C A L C O M PA N Y 05
  8. 8. E A S T M A N AT- A - G L A N C E C O AT I N G S , A D H E S I V E S , S P E C I A LT Y P O LY M E R S A N D I N K S Key Products: Coatings Additives and Solvents: Cellulosic poly- mers, adhesion promoters, Texanol ester alcohol, and solvents that include ester, ketone, glycol ether, alcohol solvents Adhesive Raw Materials: Hydrocarbon resins, rosin resins, resin dispersions, polymer raw materials Key Markets and Applications: Coatings Additives and Solvents: Architectural latex paints, automotive OEM and refinish paints, printing inks, industrial OEM paints Adhesive Raw Materials: Adhesives (tapes and labels, packaging adhesives, and nonwovens such as disposable diapers, feminine products, pre-saturated wipes) Key Raw Materials: Coatings Additives and Solvents: Acetone, butane, coal, ethane, natural gas, propane, propylene, wood pulp Adhesive Raw Materials: Butane, C9 resin oil, ethane, natural gas, piperlene, propane, pygas Key Competitors: BASF Corporation, Dow Chemical Company, ExxonMobil Corporation P O LY M E R S Key Products: Polyethylene terephthalate (PET) polymers and Eastman products are found throughout polyethylene (PE) products including low density polyethylene your house, but they’re not household (LDPE) and linear low density polyethylene (LLDPE) names. They’re the ingredients that give strength and design and functionality to Key Markets and Applications: Beverage and food packaging, the things touching your life every day. custom-care and cosmetics packaging, health care and pharma- ceutical uses, household products, industrial packaging Our more than 1,200 products are used applications, extrusion coating, film and molding applications in making everything from the packaging for your food, drinks and personal care Key Raw Materials: Ethane, ethylene glycol, paraxylene, propane, products, to the fabric in your clothing purified terephthalic acid (PTA), refinery liquids and home furnishings, to the paint on your Key Competitors: DAK Americas, Dow Chemical Company, house and automobile, to the plastics on Equipolymers, Equistar Chemical Company, ExxonMobil your bicycle helmet and golf clubs. We Corporation, Far Eastern Textiles Ltd., Huntsman Corporation, can be found in all these things, plus so Invista, M&G, Nan Ya Plastics Corporation, NOVA Chemicals many more. Corporation, Reliance Industries Ltd., Wellman Inc., Westlake Chemical Corporation At home, at work and at play, we’re with you all day, every day. Eastman products make your life safer, easier, more conven- ient and more enjoyable. 06 E A S T M A N C H E M I C A L C O M PA N Y
  9. 9. Packaging 43.99% Durables 4.81% Tobacco 11.10% Graphic Imaging 4.47% MAJOR MARKETS Transportation 8.33% Agriculture 3.32% BY REVENUE Consumables 7.18% Distributed Resources 2.65% P E R C E N TA G E Building and Construction 6.52% Electronics 1.94% Health/Wellness 5.69% FIBERS Key Products: Acetate tow, acetate yarn (Estron and Chromspun acetate yarns), acetyl chemical products (acetate flake, acetylation-grade acetic acid, acetic anhydride), triacetin plasticizers Key Markets and Applications: Cigarette filters, apparel, home furnishings, industrial applications P E R F O R M A N C E C H E M I C A L S & I N T E R M E D I AT E S Key Raw Materials: High sulfur coal, wood pulp Key Competitors: Celanese Corporation, Mitsubishi, Rhodia Key Products: Acetic anhydride, acetaldehyde, oxo derivatives, plasticizers, glycols, polymer intermediates, diketene derivatives, specialty ketones, specialty andydrides Key Markets and Applications: Agrochemical, automotive, beverages, nutrition, pharmaceuti- cals, coatings, flooring, medical devices, toys, photographic and imaging, household products, polymers, textiles, industrials Key Raw Materials: Coal, ethane, natural gas, propane Key Competitors: BASF Corporation, Celanese Corporation, Dow Chemical Company, ExxonMobil Corporation S P E C I A LT Y P L A S T I C S Key Products: Engineering and Specialty Polymers: Polyesters, copolyesters, alloys, cellulose flake, cellulosic plastics Specialty Film and Sheet: Copolyesters, Eastar copolyester, Embrace copolyester, Spectar copolyester Packaging, Film and Fiber: Cellulose esters, copolyesters, specialty polyesters, concentrates/additives Key Markets and Applications: Engineering and Specialty Polymers: Durable goods, medical goods, personal care and consumer goods Specialty Film and Sheet: Packaging, in-store fixtures and displays, building and construction, medical and electronic component trays, shrink label films, general purpose packaging, multilayer films Packaging, Film and Fiber: Photographic film, optical film, fibers/nonwovens, tapes/labels Key Raw Materials: Ethylene glycol, paraxylene, PTA Key Competitors: Engineering and Specialty Polymers: Bayer AG, Dow Chemical Company, GE Plastics, LANXESS Corporation, NOVA Chemicals Corporation Specialty Film and Sheet: Atoglas, Bayer AG, CYRO Industries, Dow Chemical Company, GE Plastics, INEOS, Selenis, SK Chemical Industries Packaging, Film and Fiber: Acetati SpA, Daicel Chemical Industries E A S T M A N C H E M I C A L C O M PA N Y 07
  10. 10. quot;I embarrass my wife in supermarkets because I’m always picking up objects and saying, ‘There's Eastman in this!’ It's gratifying to see our products on store shelves and know that I helped put them there.quot; – Tom Pecorini, Ph.D., Senior Associate, Polymers Technology In 2004, we launched www.EastmanInnovationLab.com. This award-winning site is an interactive, community-based resource for designers and brand owners. Peter Anell, founder and Chief Creative Officer of the Arnell Group, says, “The Eastman Innovation Lab brings a visitor into a world that clearly conveys credibility and expertise.” (Left to right): Cathy Combs, Manager, Employee Service Center & Payroll; Mike Cradic, Technical Service Representative; Tom Pecorini, Senior Associate, Polymers Technology 08 E A S T M A N C H E M I C A L C O M PA N Y
  11. 11. THE FACE OF INNOVATION It takes a combination of detective work, psychology and science to develop innovations that fulfill unmet customer needs. We start with a fuzzy, gray area to be addressed somehow, in some way. With a collaborative process and a common framework across all science and business disciplines, we come to understand what’s needed, what’s technically possible and how to provide the best value to customers. S U C C E S S F R O M I N N O V AT I O N It’s hard to gaining great visibility, even though you can see pinpoint where innovation comes from – and right through many of our products. At the Torino even harder to turn promising projects into 2006 Olympic Games, the 12,000 transparent market successes. Our work begins by talking seats in the new ice hockey stadium were with customers at each point in the value chain – injection-molded using our high-performance Durastar copolyester. In the rock-‘n’-roll world, designers, brand owners, fabricators, retailers, consumers – to understand their motivation and the award-winning RKS “Pop Series” open- architecture electric guitar uses our Tenite cellu- identify unmet needs in areas where we can deliver value. We probe to find out what keeps losics to achieve tonal quality and translucent them up at night and what bothers them about or opaque colors in its breakthrough, hollow- existing products. Then we dig into our toolbox body design. In custom container packaging, our Eastar copolyesters deliver design flexibility of breakthrough technologies, chemical and process expertise, or some other proprietary and glass-like clarity, allowing for the creation know-how to create superior value propositions of clear handles for larger containers. Integrated that benefit our customers and their customers. handles make pouring easier for kids, those with disabilities, the elderly – for all of us. B E T T E R I D E A S As performance needs change, Embrace shrink film is an innovation our so must our products. So when our U.S. architec- tural coatings customers needed formulation customers like for its excellent printability, solutions to meet VOC regulatory requirements, strength and durability. Yet they also wanted we put our resources to work. The result was our a film that is more recycle-friendly and that new, high-performance Optifilm Enhancer 400. provides protection against ultraviolet light. Working together with our trusted brand of We listened, then went to work. Now, with Texanol ester alcohol, Optifilm Enhancer 400 Embrace High Yield shrink film, customers can gives our customers confidence that they can produce containers with the same bold graphics meet environmental regulations without sacrific- while achieving higher yields per pound of resin, ing quality. greater recyclability and better light-blocking properties that preserve the contents’ flavor and Another place to see Eastman innovation at work nutritional value. is in our family of plastics. Here, our ingenuity is E A S T M A N C H E M I C A L C O M PA N Y 09
  12. 12. THE FACE OF LEADERSHIP The key to our market-leading standing is neither simply our size nor our longevity; it’s both combined with our technology. In many areas, our technology is simply the best – and we continue to make it better. Today we are the largest producer of PET polymers, and we intend to strengthen our leadership position through our breakthrough IntegRex PET technology. Building an entirely new technology platform And the effort paid off. In 2004 we announced IntegRex, a breakthrough technology that takes experience and knowledge. Creativity alone won’t do it. You need a thorough founda- includes numerous innovations that reduce tion in the science and the market. That’s the the number of intermediate process steps in formula we used to develop our first patent in producing PET resin. 1973 for producing PET plastic containers for IntegRex has become the launching point for carbonated beverages. We’ve been an innovator in the industry ever since. our uniquely integrated polyester strategy, encompassing breakthrough PET technology, L E A D I N G T E C H N O L O G Y In 2002, we took economies of scale and differentiated polyester an entirely new approach to a seemingly products and solutions. This is only the leading impossible project: strengthen Eastman’s world edge of what we can do in the polyester arena leadership position by developing low-cost to maintain our leadership position through PET process technology – all within 30 months. technology and innovation. The technology had to reduce the space and The code name for the IntegRex project was resource requirements needed to build and run a plant, increase production capacity VR-1, but we are also ready for VR-N, where “N” considerably and be difficult to copy. stands for the infinite number of iterations left in the innovation cycle. In early 2005, we broke D O I N G T H I N G S D I F F E R E N T LY Three teams ground on the first world-scale facility using IntegRex technology at our site in Columbia, were assembled and given top-level support and resources. Team members continually South Carolina; it is expected to come on-line challenged themselves to do things differently, during the fourth quarter of 2006 and be fully to break down barriers, shift paradigms, push operational in early 2007. It’s the next step in our boundaries, and re-think conventional wisdom. commitment to maintain our leadership position The enthusiasm was contagious. So was the through technology and innovation. entrepreneurial thinking. 10 E A S T M A N C H E M I C A L C O M PA N Y
  13. 13. “I believe Eastman’s success comes from taking calculated risks in areas we know and have capabilities. We are just now beginning to fully realize the potential that IntegRex can have on extending our overall leadership in polyesters.” – T.J. Stevens, Group Vice President, Polymers Tom Winn, Chemical Engineer E A S T M A N C H E M I C A L C O M PA N Y 11
  14. 14. “Working on chemicals from coal has been, and will always be, the highlight of my career. What Eastman did in the ’70s and ’80s wasn’t incremental; it was groundbreaking.” – Bill Trapp, Operations Manager, Gasification Services 12 E A S T M A N C H E M I C A L C O M PA N Y
  15. 15. THE FACE OF POSSIBILITY “What if…?” These two little words have led to some amazing transformations at Eastman. By constantly challenging ourselves and thinking about the possibilities, we make Eastman a better company. The results are visible in our product and technology development, our nonstop process improvements and our exploration of new ideas. By asking “What if…,” we find new and unique ways to create value for all our stakeholders. What if we could eliminate a chunk of Eastman’s from petroleum. Reaching this point took some raw materials costs – the largest cost compo- doing: the licensing and improvement of emerg- nent in making chemicals? And what if we could ing coal gasification technology, invention of new reduce dependence on petroleum and natural processes, and scale-up and commercialization gas at the same time? Enter our chemicals from of downstream Eastman technologies to convert coal initiative. While it seems particularly timely synthesis gas to acetyl chemicals. It also took a with today’s volatile raw material prices, the leap of faith that we could make it reliable, effi- original effort dates to the 1970s. cient and cost-effective to build. Our expertise in chemical process development, manufacturing M A K I N G C H E M I C A L S F R O M C O A L The and commercialization made success possible. 1973 oil embargo triggered petroleum short- ages, skyrocketing prices and the seed of an For more than 20 years, our coal gasification idea in the minds of Eastman leaders. What if plant has run at best-in-class production rates the company could replace petroleum and natu- and now satisfies 100% of our demand for ral gas with a more secure and domestically acetyl raw materials. In 2005, about 20% of available raw material? The answer was coal, our product volume – and about 50% of our the world’s most abundant fossil fuel. The fact operating earnings – came from acetyl chemicals that the company’s largest manufacturing facil- produced by coal gasification. Now we wonder: ity is located in the heart of the Appalachian What if we could expand our use of coal as a coalfields seemed fortuitous. raw material? Active research and development began on a R E P L I C AT I N G O U R S U C C E S S To answer coal-based process and, in 1983, the Kingsport, this question, we have assembled teams of Tenn., facility became the first commercial coal engineers and scientists, including some who gasification plant in the U.S. – and the first to worked on the original plant, in order to repli- produce acetyl chemicals from coal instead of cate our success. Our work continues, and we are optimistic about the possibilities ahead. Facing page (clockwise from top left): Brenda Barnicki, Director, Gasification Services; Matt Adams, Utility Operator, Gasification Department; Jeff Fain, Team Manager, Acetic Anhydride Department; Bill Trapp, Operations Manager, Gasification Services E A S T M A N C H E M I C A L C O M PA N Y 13
  16. 16. THE FACE OF COLLABORATION Eastman is more than a supplier; we’re a partner. We want our customers, and their customers, to be successful. The “product” that leaves our gates can be a pellet, resin, flake, powder, solvent or yarn. But with input from designers, brand owners, converters, even retailers, it becomes the juice bottle or eyeglasses or fashionable dress you eventually see, and buy. We collaborate across the whole value chain to deliver the right product, with the right characteristics at the right price. Collaboration requires relationships, and rela- Eastman is helping Chico’s “control our own tionships are built on trust. That’s why we work destiny,” says Chico’s CEO Scott Edmonds. hard to maintain the trust of our customers. They “It’s great to deal with a company like Eastman. appreciate our commitment and longevity, know- When they look me in the eye, shake my hand ing we’re not “here today, gone tomorrow.” and tell me something will happen, it happens.” S P I N N I N G A G R E AT YA R N One of our G O I N G E A S T Our China Technology Center oldest businesses is breathing new life thanks in Shanghai is another tale of Eastman collab- to a successful collaboration. Eastman acetate oration. Opening with great interest from our yarn, soon to celebrate its 75th anniversary, customers in November 2005, it provides an has faced tough challenges in recent years, operations base for technical service repre- with threats from polyester and other fibers. sentatives across all Eastman businesses. With But today this business is profitable and the new laboratory, we are able to target growth thriving, and our growing relationship with markets in Asia and extend our technical capa- specialty retailer Chico’s played a major role bilities to customers in the fastest growing in both companies’ fortunes. region in the world. When a major competitor announced it was We now can work more closely with our key exiting the business in October 2004, represen- partners there and, in many cases, are bringing tatives from Chico’s and Eastman’s acetate yarn them to the facility to collaborate in the work business were on the phone with each other being done. This strategic investment represents within days. Chico’s wanted a secure source of our latest commitment to the Asian market, acetate yarn for its popular Travelers™ Collection providing faster technical assistance and facili- of high fashion, high performance women’s tating strategic or joint development projects clothing. With coal as our steady, economical and partnerships. source of raw material, we were able to assure Chico’s of a reliable supply of high quality acetate yarn. 14 E A S T M A N C H E M I C A L C O M PA N Y
  17. 17. Brazilian cosmetic company Natura chose Eastman’s The Glass Polymer copolyester for several packaging applications. “We always think of Eastman, not only because of its innovative materials, but also due to the fact it is a company committed to help on the development of new projects, side by side with the molder and with us. Eastman’s innovation, partnership spirit and support are what differentiate the company from other resin producers.” – Renato Wakimoto, Packaging Development Manager, Natura (Left to right): Scott Ballard, Global Product Manager, Coalescents & Specialty Ketones; Andy Lu, Director, Business and Commercial Development, Asia Pacific E A S T M A N C H E M I C A L C O M PA N Y 15
  18. 18. THE FACE OF CARING Throughout our 86-year history, one constant has been our culture of caring. We live this value every day by making sure our products and plants are safe, going to great lengths to protect the environment and involving ourselves in our local communities. W O R K I N G R E S P O N S I B LY As a Responsible from our foundation. Another is through the Care® company, we use an industry-wide system generosity and volunteer efforts of our people. to drive health, safety, environmental and secu- Their hearts and hands helped numerous rity (HSES) performance. This helps us assess worthy causes in 2005, including: our needs, set specific performance goals and share our progress with the public. • Employees in Kingsport, Tenn., gave nearly $2 million to the local United Way, and approx- Many of our facilities were recognized for imately 600 employees volunteered during their HSES achievements in 2005. Four manu- the agency’s Week of Caring. facturing organizations were recognized for • In Zarate, Argentina, Eastman sponsored improved energy efficiency, while 18 organiza- The Reading Room, a reading promotion tions achieved “best ever” safety results. At program of “Fundación Leer,” in several our Tennessee site, we converted our fleet of different schools throughout the area. diesel equipment to use a biodiesel blend to • In Malaysia, employees received national help reduce air pollution and our dependence recognition for their efforts to improve the on foreign oil. performance of underprivileged students on a nationalized test. A G O O D N E I G H B O R Caring for others extends • In Singapore, employees organized a fundrais- beyond our operational performance; we also ing fair at a children’s home for orphans to want to be the neighbor of choice. One way we improve and upgrade the facility. support our local communities is through grants (Left to right): Eastman sponsored the annual South Carolina Envirothon. Employees in the Netherlands participated in National Read a Story Day. Eastman hosted a Health Fair for retirees, active employees and their families. In Texas, Eastman supported scholars at Jarvis Christian College. 16 E A S T M A N C H E M I C A L C O M PA N Y
  19. 19. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K (Mark One) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [X] For the fiscal year ended December 31, 2005 OR [] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________ to ______________ Commission file number 1-12626 EASTMAN CHEMICAL COMPANY (Exact name of registrant as specified in its charter) Delaware 62-1539359 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 200 South Wilcox Drive Kingsport, Tennessee 37660 (Address of principal executive offices) (Zip Code) Registrant’s telephone number, including area code: (423) 229-2000 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on which registered Title of each class Common Stock, par value $0.01 per share New York Stock Exchange (including rights to purchase shares of Common Stock or Participating Preferred Stock) Securities registered pursuant to Section 12(g) of the Act: None ____________________________________________________________________________________________ PAGE 1 OF 141 TOTAL SEQUENTIALLY NUMBERED PAGES EXHIBIT INDEX ON PAGE 127 1
  20. 20. Yes No Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the [X] Securities Act. Yes No Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of [X] the Securities Exchange Act of 1934. Yes No Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 [X] or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not [X] contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the [X] Securities Exchange Act of 1934). Yes No Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the [X] Exchange Act). The aggregate market value (based upon the closing price on the New York Stock Exchange on June 30, 2005) of the 81,373,319 shares of common equity held by nonaffiliates as of December 31, 2005 was approximately $4,487,738,542 using beneficial ownership rules adopted pursuant to Section 13 of the Securities Exchange Act of 1934, as amended, to exclude common stock that may be deemed beneficially owned as of December 31, 2005 by the directors and executive officers and Eastman Chemical Company’s (“Eastman” or the “Company”) charitable foundation, some of whom might not be held to be affiliates upon judicial determination. A total of 81,637,985 shares of common stock of the registrant were outstanding at December 31, 2005. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive Proxy Statement relating to the 2006 Annual Meeting of Stockholders (the quot;2006 Proxy Statementquot;), to be filed with the Securities and Exchange Commission, are incorporated by reference in Part III, Items 10 to 12 and 14 of this Annual Report on Form 10-K (the quot;Annual Reportquot;) as indicated herein. FORWARD-LOOKING STATEMENTS Certain statements in this Annual Report are forward-looking in nature as defined in the Private Securities Litigation Reform Act of 1995. These statements, and other written and oral forward-looking statements made by the Company from time to time, may relate to, among other things, such matters as planned and expected capacity increases and utilization; anticipated capital spending; expected depreciation and amortization; environmental matters; legal proceedings; exposure to, and effects of hedging of, raw material and energy costs and foreign currencies; global and regional economic, political, and business conditions; competition; growth opportunities; supply and demand, volume, price, cost, margin, and sales; earnings, cash flow, dividends, and other expected financial conditions; expectations, strategies, and plans for individual assets and products, businesses, segments, and divisions as well as for the whole of Eastman Chemical Company; cash requirements and uses of available cash; financing plans; pension expenses and funding; credit ratings; anticipated restructuring, divestiture, and consolidation activities; cost reduction and control efforts and targets; integration of acquired businesses; development, production, commercialization, and acceptance of new products, services and technologies and related costs; asset, business and product portfolio changes; and expected tax rates and net interest costs. 2
  21. 21. These plans and expectations are based upon certain underlying assumptions, including those mentioned with the specific statements. Such assumptions are in turn based upon internal estimates and analyses of current market conditions and trends, management plans and strategies, economic conditions, and other factors. These plans and expectations and the assumptions underlying them are necessarily subject to risks and uncertainties inherent in projecting future conditions and results. Actual results could differ materially from expectations expressed in the forward-looking statements if one or more of the underlying assumptions and expectations proves to be inaccurate or is unrealized. Certain important factors that could cause actual results to differ materially from those in the forward-looking statements are included with such forward-looking statements and in Part II—Item 7— quot;Management's Discussion and Analysis of Financial Condition and Results of Operations—Forward-Looking Statements and Risk Factors of this Annual Report on Form 10-K.quot; 3
  22. 22. TABLE OF CONTENTS ITEM PAGE PART I 1. Business 5 1A. Risk Factors 27 1B. Unresolved Staff Comments 27 Executive Officers of the Company 28 2. Properties 30 3. Legal Proceedings 31 4. Submission of Matters to a Vote of Security Holders 32 PART II 5. Market for the Registrant's Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities 33 6. Selected Financial Data 35 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 36 7A. Quantitative and Qualitative Disclosures About Market Risk 69 8. Financial Statements and Supplementary Data 70 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 121 9A. Controls and Procedures 121 9B. Other Information 121 PART III 10. Directors and Executive Officers of the Registrant 122 11. Executive Compensation 122 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 122 13. Certain Relationships and Related Transactions 123 14. Principal Accounting Fees and Services 123 PART IV 15. Exhibits and Financial Statement Schedules 124 SIGNATURES Signatures 125 4
  23. 23. PART I ITEM 1. BUSINESS CORPORATE OVERVIEW History, Business, and Recent Results Eastman Chemical Company (quot;Eastmanquot; or the quot;Companyquot;) is a global chemical company which manufactures and sells a broad portfolio of chemicals, plastics, and fibers. Eastman began business in 1920 for the purpose of producing chemicals for Eastman Kodak Company's photographic business and became a public company, incorporated in Delaware, as of December 31, 1993. Eastman has 17 manufacturing sites in 10 countries that supply chemicals, plastics, and fibers products to customers throughout the world. The Company's headquarters and largest manufacturing site are located in Kingsport, Tennessee. In 2005, the Company had sales revenue of $7.1 billion, operating earnings of $757 million, and net earnings of $557 million. Earnings per diluted share were $6.81 in 2005. Included in 2005 operating earnings were asset impairments and restructuring charges of $33 million and other operating income of $2 million. The Company’s products and operations are managed and reported in six operating segments aligned into three divisions: Eastman, Voridian and Developing Businesses. Eastman Division consists of the Coatings, Adhesives, Specialty Polymers, and Inks (“CASPI”) segment, the Performance Chemicals and Intermediates (“PCI”) segment and the Specialty Plastics (“SP”) segment. Voridian Division consists of the Polymers segment and the Fibers segment. Developing Businesses Division consists of the Developing Businesses (“DB”) segment. A segment is determined primarily by the customer markets in which it sells its products and services. For additional information related to the Company’s operating segments, see Note 21 to the Company’s consolidated financial statements in Part II, Item 8 of this 2005 Annual Report on Form 10K. On March 6, 2006, the Company announced a realignment of its organizational structure and related senior management assignments effective April 1, 2006. The new structure combines related assets and technologies to facilitate growth in the Company's core businesses and take full advantage of new growth opportunities by focusing on common technologies and streams. The new organization replaces the Eastman and Voridian divisions with the Chemicals and Fibers Group and the Polyesters Group. The Chemicals and Fibers Group consists of CASPI, PCI, and Fibers segments. The Polyesters Group consists of SP and Polymers segments. Manufacturing Streams Eastman's objective is to leverage its heritage of expertise and innovation in acetyl, polyester, and olefins chemistries to drive growth, meet increasing demand and create new opportunities for the Company's products in key markets including packaging, tobacco, durable goods, building and construction, and others. For each of these chemistries, Eastman has developed a combination of assets and technologies that are operated within three manufacturing 'streams'. In the acetyl stream, the Company begins with high sulfur coal which is then gasified in its coal gasification facility. The resulting synthesis gas is converted into a number of chemicals including methanol, methyl acetate, acetic acid and acetic anhydride. These chemicals are used in products throughout the Company including acetate tow, acetate yarn and cellulose esters. The Company's ability to use coal is a competitive advantage for raw materials and energy. The Company is investigating opportunities to further leverage its coal- based process know-how in an effort referred to as quot;chemicals from coalquot;. In the polyester stream, the Company begins with purchased paraxylene and produces purified terephthalic acid (quot;PTAquot;) and dimethyl terephthalate (quot;DMTquot;) which are the starting raw materials of most of its polyester competitors. PTA or DMT is then reacted with ethylene glycol, which the Company both makes and purchases, along with other ingredients (some of which the Company makes and are proprietary) to produce polyethylene terephthalate (quot;PETquot;) and copolyesters. This backward integration of its polyester manufacturing provides several competitive advantages. For PET, this allows Eastman a cost advantage in a commodity market. For copolyester, Eastman adds a specialty monomer to provide clear, tough, chemically resistant product characteristics. As a result, the Company's copolyesters can compete with materials such as polycarbonate and acrylic. In the olefins stream, the Company begins primarily with propane and ethane, which are then cracked at its facility in Longview, Texas into propylene and ethylene. The propylene is used in oxo derivative products, while the ethylene is primarily used in polyethylene products. 5
  24. 24. The following chart shows markets and significant Eastman products by segment and manufacturing stream. SEGMENTS ACETYL POLYESTER OLEFINS KEY PRODUCTS, MARKETS AND END STREAM STREAM STREAM USES Adhesives (tape, label, nonwovens), paint and coatings (architectural, automotive, CASPI industrial, and original equipment X X manufacturing quot;OEMquot;) Agrochemical, automotive, beverages, nutrition, pharmaceuticals, coatings, medical devices, toys, photographic and PCI X X X imaging, household products, polymers, textiles, and consumer and industrials Appliances, store fixtures and displays, building and construction, electronic packaging, medical devices and packaging, personal care and cosmetics, performance SP X X X films, tape and labels, fibers/nonwovens, photographic and optical film, graphic arts and general packaging Beverage and food packaging, custom-care and cosmetic packaging, health care and pharmaceutical uses, household products Polymers and industrial packaging applications, X X X extrusion coating, film and molding applications Acetate tow, apparel, home furnishings, and Fibers industrial applications X Cyclicality and Seasonality Certain segments, particularly the PCI and Polymers segments, are impacted by the cyclicality of key products and markets, while other segments are more sensitive to global economic conditions. Supply and demand dynamics determine profitability at different stages of cycles and global economic conditions affect the length of each cycle. Despite some sensitivity to global economic conditions, many of the products in the Fibers, CASPI and SP segments provide a stable foundation of earnings. The Company typically experiences seasonality in its earnings and cash flows. The Company's earnings are typically higher in the second and third quarters, while cash from operations is stronger in the first and fourth quarters. Demand for CASPI segment products is typically stronger in the second and third quarters due to increased use of coatings products in the building and construction industries, while demand is weaker during the winter months because of seasonal construction downturns. The PCI segment typically experiences a weaker fourth quarter, due in part to a downturn in demand for products used in certain building and construction and agricultural markets. The Polymers segment typically experiences stronger demand for PET polymers for beverage plastics during the second and early third quarters due to higher consumption of beverages in the Northern hemisphere, while demand typically weakens during the late third and fourth quarters. 6
  25. 25. EASTMAN DIVISION Business and Industry Overview Operating in a variety of markets with varying growth prospects and competitive factors, the segments in Eastman Division manufacture a diverse portfolio of specialty and commodity chemicals and plastics that are used in a wide range of consumer and industrial markets. Eastman Division has 13 manufacturing sites in 8 countries, selling more than 1,650 products to more than 3,500 customers. Eastman Division is comprised of the CASPI, PCI, and SP segments, which are more fully discussed below. Strategy The Company’s objectives for Eastman Division are to exploit growth opportunities in core businesses and improve gross margins. • Exploit Growth Opportunities in Core Businesses Develop New Specialty Products and Expand into New Markets The Company believes that it is a market leader based on sales in a number of Eastman Division’s product lines. The Division is focused on growth through continued innovation and displacement of competitive products with offerings that provide greater functionality or better value. This includes development of new products for existing applications, and expansion into new applications with existing products. Leverage Opportunities Created by the Broad Product Line Eastman Division is able to offer a broad array of complementary products that customers would otherwise need to obtain from multiple manufacturers. Its diverse portfolio and integrated manufacturing assets allow Eastman Division to benefit from advancements and developments with respect to one product line by applying them to other product lines. For example, efficiency is created through the operation of large integrated plants that produce numerous products, which are used in, or sold by, multiple Eastman segments. This allows a customer to place an order for multiple products, which may be produced by different segments, and have them delivered from the same location, reducing costs and order time. Additionally, Eastman continues to leverage the advantages of being an integrated polyester manufacturer. One opportunity identified is scaled differentiation in the polyester stream, which is the potential for SP to utilize rationalized PET assets, as a result of the new IntegRex facility, to reduce copolyester conversion cost. This would be expected to leverage the synergies of the Polymers segment's advantaged cost structure and the SP segment's potential to expand quickly into higher value growth markets. Diversify Globally and Pursue Opportunities for Business Development Eastman Division currently has in place and continues to pursue opportunities for joint ventures, equity investments and other alliances. These strategic initiatives are expected to diversify and strengthen businesses by providing access to new markets and high-growth areas as well as providing an efficient means of ensuring that Eastman is involved in diverse technological innovations in or related to the chemicals industry. The Company is committed to pursuing these initiatives in order to capitalize on new business concepts that differentiate it from other chemical manufacturers and that will provide incremental growth beyond what is organic to the chemicals industry and at lower capital investment. For example, Eastman is expanding its manufacturing joint venture in Nanjing, China to meet the growing demand in Asia for hydrocarbon resins in adhesives formulations. Additionally, Eastman is increasing copolyester intermediates capacity in order to meet expected growth in global demand. • Improve Gross Margins Eastman Division continues to work to maximize the value of core businesses by improving gross margins through: Enhancing pricing processes and strategies, and implementing pricing systems to improve responsiveness to changes in operating costs and other factors impacting gross margins; 7
  26. 26. Institutionalizing cost reduction processes, including a Six Sigma quality improvement program aimed at reducing costs, improving customer satisfaction, improving efficiency through reduction of variations and defects, and focusing on business simplification and channels to market; Implementing information technology solutions to maximize the Company’s enterprise resource planning system used in production planning and other manufacturing processes to reduce safety stock, improve responsiveness to demand forecasting, and increase manufacturing efficiency; and Maintaining high utilization of manufacturing assets, particularly for intermediates and specialty polymers, and pursuing high value debottlenecking opportunities and incremental expansions of current assets. Related to the above activities, the Company continues to evaluate its portfolio of products and businesses in Eastman Division, which could result in further restructuring, divestiture, or consolidation, particularly in the PCI segment. CASPI SEGMENT • Overview The CASPI segment manufactures liquid vehicles, additives, specialty polymers, and other raw materials which are integral to the production of paints and coatings, inks, adhesives, and other formulated products. The CASPI segment focuses on producing raw materials rather than finished products in order to develop long-term, strategic relationships and achieve preferred supplier status with its customers. Growth in these markets in North America and Europe typically approximates economic growth in general, due to the wide variety of end uses for these applications and dependence on the economic conditions of the markets for durable goods, packaged goods, automobiles, and housing. However, higher growth sub-markets exist within North America and Europe, driven by customers' growing demands for performance requirements that are protective of the environment and meet increasingly more stringent government regulation. For example, the coatings and adhesives industries are promoting products and technologies designed to reduce air emissions. Growth in Asia and Latin America is substantially higher than general economic growth, driven primarily by the increasing government regulations in industrializing economies. In 2005, the CASPI segment had sales revenue of $1.3 billion, which represented 18 percent of Eastman’s total sales and 36 percent of Eastman Division’s total sales. • Products The CASPI segment's products consist of: Coatings Additives and Solvents The additives product lines consist of differentiated and proprietary products such as: cellulosic polymers, which enhance the aesthetic appeal and improve the performance and metallic flake orientation of industrial and automotive original equipment and refinish coatings and inks; Texanol™ ester alcohol, which improves film formation and durability in architectural latex paints; and chlorinated polyolefins, which promote the adherence of paints and coatings to plastic substrates. Solvents, which consist of ester, ketone, glycol ether and alcohol solvents, are used in both paints and inks to maintain the formulation in liquid form for ease of application. Environmental regulations that impose limits on the emission of hazardous air pollutants continue to impact coatings formulations requiring compliant coatings raw materials. Eastman’s coatings additives and solvents are currently used in compliant coatings. Additional products are under development to meet the growing demand for waterborne (latex) and high solids coatings that are more protective of the environment. Coatings additives and solvents comprised 59 percent of the CASPI segment’s total sales for 2005. 8
  27. 27. Adhesives Raw Materials The adhesives product line consists of hydrocarbon resins, rosin resins, resin dispersions, and polymer raw materials. These products are sold to adhesive formulators and tape and label manufacturers for use as raw materials in hot melt and pressure sensitive adhesives and as binders in nonwoven products (such as disposable diapers, feminine products, and pre-saturated wipes). Eastman has a leadership position in hydrogenated gum rosins used in adhesive and chewing gum applications. Eastman offers the broadest product portfolio of raw materials for the adhesives industry, ranking as the second largest global tackifier supplier. Adhesives raw materials comprised 41 percent of the CASPI segment’s total sales for 2005. The profitability of CASPI products is sensitive to the global economy, exchange rates, and market trends and broader chemical cycles, particularly the olefins cycle. CASPI's specialty products, which include coatings additives, coalescents, and selected hydrocarbon resins, are less sensitive to the olefins cycle due to their functional performance attributes. The cyclical commodity products, which include commodity solvents and polymer raw materials, are impacted by the olefins cycle. The Company leverages its proprietary technologies, competitive cost structure and integrated manufacturing facilities to maintain a strong competitive position throughout such cycles. • Strategy A key element of the CASPI segment growth strategy is the continued development of innovative product offerings, building on proprietary technologies in high-growth markets and regions that meet customers’ evolving needs and improve the quality and performance of customers’ end products. Eastman Division believes that its ability to leverage its broad product line and research and development capabilities across this segment make it uniquely capable of offering a broad array of solutions for new and emerging markets. CASPI is pursuing high value incremental expansions of current manufacturing assets to ensure that adequate capacity is available to meet the increasing demand for its differentiated products. The CASPI segment is focused on the expansion of the coatings and inks additives and solvents product offerings into other high-growth areas. These include market areas with growth due to specific market trends and product developments, such as high solids and water-based coatings and inks, as well as growth in geographic areas due to the level and timing of industrial development. The Company's global manufacturing presence positions it to take advantage of areas of high industrial growth, particularly in Asia from its facility in Singapore and joint venture operations in China. The CASPI segment is also focused on the expansion of the adhesives raw materials product offerings into high- growth markets and regions by leveraging applications technology and increasing production capacity. The segment expects to take advantage of growth in demand for specialty hydrocarbon resins through the 25 percent expansion of manufacturing operations in Middelburg, the Netherlands, and in the developing regions through the 30 percent expansion of hydrocarbon resin production capacity at its joint venture operation in Nanjing, China. Additionally, the CASPI segment has improved profitability within this group of product lines through cost reduction initiatives and other projects that leverage best manufacturing practices, infrastructure, and business processes. The Company intends to continue to leverage its resources to strengthen its CASPI innovation pipeline through improved market connect and the expanded use of proprietary products and technologies. Although CASPI sales and application development is often specialized by end-use market, developments in technology may be successfully shared across multiple end-uses and markets. 9
  28. 28. • Customers and Markets As a result of the variety of end uses for its products, the customer base in the CASPI segment is broad and diverse. This segment has more than 1,500 customers around the world, and approximately 80 percent of its sales revenue in 2005 was attributable to approximately 100 customers. CASPI focuses on establishing long-term, customer service- oriented relationships with its strategic customers in order to become their preferred supplier and to leverage these relationships to pursue sales opportunities in previously underserved markets, as well as expand the scope of its value-added services. However, from time to time, customers decide to develop products internally or diversify their sources of supply that had been provided by Eastman. Growth in North American and European markets typically coincide with economic growth in general, due to the wide variety of end uses for these applications and their dependence on the economic conditions of the markets for durable goods, packaged goods, automobiles, and housing. • Competition Competition within the CASPI segment's markets varies widely depending on the specific product or product group. Because of the depth and breadth of its product offerings, Eastman does not believe that any one of its competitors presently offers all of the products that it manufactures within the CASPI segment. However, many of the Company’s competitors within portions of its CASPI segment are substantially larger companies, such as Dow Chemical Company (“Dow”), BASF and Exxon Mobil Corporation, which have greater financial and other resources than those of Eastman. Additionally, within each market in this segment, the Company competes with other smaller, regionally focused companies that may have advantages based on location, local market knowledge, manufacturing strength in a specific product, or other factors. At any time, any one or more of these competitors could develop additional products that compete with, or that may make obsolete, some of Eastman’s current product offerings. Eastman does not believe that any of its competitors is dominant within the CASPI segment's markets. Further, the Company attempts to maintain competitive advantages through its level of vertical integration, breadth of product and technology offerings, low-cost manufacturing position, consistent product quality, and process and market knowledge. In addition, Eastman attempts to leverage its strong customer base and long-standing customer relationships to promote substantial recurring business, further strengthening its competitive position. PCI SEGMENT • Overview The Company’s PCI segment manufactures diversified products that are sold externally, as well as used internally by other segments. PCI's earnings are highly dependent on how the Company chooses to optimize the olefins stream, and, to a lesser extent, the acetyls stream. In 2005, the PCI segment had external sales revenue of $1.6 billion, which represented 23 percent of Eastman’s total sales and 44 percent of Eastman Division's total sales. Additionally, the PCI segment had interdivisional sales revenue for 2005 of $665 million. • Products The PCI segment offers over 150 products that include intermediates based on oxo and acetyl chemistries, and performance and custom-manufactured chemicals. PCI segment's 2005 sales revenue was approximately 55 percent olefin-based, 15 percent acetyl-based, 10 percent polymer-based, and 20 percent based on performance and custom chemicals and other. Approximately 75 percent of PCI's sales revenue is generated in North America. Sales in all regions are generated through a mix of the Company’s direct sales force and a network of distributors. The Company's PCI segment is the largest marketer of acetic anhydride in the United States, an intermediate that is a critical component of analgesics and other pharmaceutical and agricultural products, and is the only U.S. producer of acetaldehyde, a key intermediate in the production of vitamins and other specialty products. Eastman manufactures one of the broadest ranges of oxo aldehyde derivatives products in the world. The PCI segment’s other intermediate products include plasticizers, glycols, and polymer intermediates. Many of the intermediate products in the PCI segment are priced based on supply and demand of substitute and competing products. In order to maintain a competitive position, the Company strives to operate with a low cost manufacturing base. 10
  29. 29. PCI also manufactures complex organic molecules such as diketene derivatives, specialty ketones, and specialty anhydrides for fiber and food and beverage ingredients, which are typically used in specialty market applications. PCI also engages in custom manufacturing where business is developed on a customer-by-customer basis. These specialty and custom manufacturing products are typically priced based on the amount of value added rather than supply and demand factors. PCI produces nonanoyloxybenzenesulfonate bleach activator (quot;NOBSquot;) for a key customer. • Strategy To build on and maintain its status as a low cost producer, PCI continuously focuses on cost control, operational efficiency, and capacity utilization to maximize earnings. Through the PCI segment, the Company maximizes the advantage of its highly integrated and world-scale manufacturing facilities. For example, the Kingsport, Tennessee manufacturing facilities allow the PCI segment to produce acetic anhydride and other acetyl derivatives from coal rather than natural gas or other petroleum feedstocks. Similarly, at the Longview, Texas facility, the PCI segment utilizes propane and local ethane supplies along with Eastman's proprietary oxo-technology in the world’s largest single-site, oxo aldehyde manufacturing facility to produce a wide range of alcohols, esters, and other derivative products. These integrated facilities, combined with large scale production processes and a continuous focus on additional process improvements, allow the PCI segment to remain cost competitive with, and for some products cost-advantaged over, its competitors. A recent example of Eastman’s continuous pursuit of cost and productivity improvement is the implementation of a successful cost reduction program within the acetyl production operations at the Kingsport site. Benefits from this effort allow the PCI segment to take advantage of the Company's strategic position within acetyl and related derivative markets. The PCI segment selectively focuses on continuing to develop and access markets with high-growth potential for the Company’s chemicals. The Company engages in customer focused research and development initiatives in order to develop new products and find additional applications for existing products. In the future, the Company expects to capitalize on such applications in the personal care and specialty solvents markets. The Company continues to evaluate the various businesses and product lines within the PCI segment, which could result in restructuring, divestiture, or consolidation to improve profitability. • Customers and Markets The PCI segment’s products are used in a variety of markets and end uses, including agrochemical, automotive, beverages, nutrition, pharmaceuticals, coatings, flooring, medical devices, toys, photographic and imaging, household products, polymers, textiles, and industrials. The markets for products with market-based pricing in the PCI segment are cyclical. This cyclicality is caused by periods of supply and demand imbalance, either when incremental capacity additions are not offset by corresponding increases in demand, or when demand exceeds existing supply. Demand, in turn, is based on general economic conditions, raw material and energy prices, consumer demand and other factors beyond the Company’s control. Eastman may be unable to increase or maintain its level of PCI sales in periods of economic stagnation or downturn, and future PCI results may fluctuate from period to period due to these economic conditions. The Company believes many of these markets are being positively affected by the current olefins upcycle. However, product-specific olefin derivative markets display a range of strength based upon prevailing supply/demand conditions. An important trend within PCI's markets is a tendency toward increased regionalization of key markets, especially acetyls and olefins, due to increased transportation costs. During 2005, the PCI segment entered into a long-term arrangement with a Middle-Eastern company that will allow Eastman to leverage its proprietary acetyl technology to obtain access to acetyl chemicals produced in the Middle East region. Additionally, the PCI segment is engaged in continuous efforts directed toward optimizing product and customer mix. Approximately 80 percent of the PCI segment’s sales revenue in 2005 was associated with 90 out of approximately 1,250 customers worldwide. 11
  30. 30. • Competition Historically, there have been significant barriers to entry for competitors with respect to a majority of PCI's products, primarily due to the fact that the relevant technology has been held by a small number of companies. As this technology has become more readily available, competition from multinational chemical manufacturers has intensified. Eastman competes with these and other producers primarily based on price, as products are interchangeable, and, to a lesser extent, based on technology, marketing and other resources. Eastman’s major competitors in this segment include large multinational companies such as Dow, Celanese Corporation, BASF, and Exxon Mobil Corporation. While some of the Company’s competitors within the PCI segment have greater financial resources than Eastman, which may better enable them to compete on price, the Company believes it maintains a strong position due to the combination of its scale of operations, breadth of product line, level of integration, and technology leadership. SP SEGMENT • Overview The SP segment produces highly specialized copolyesters and cellulosic plastics that possess unique performance properties for value-added end uses such as appliances, store fixtures and displays, building and construction, electronic packaging, medical devices and packaging, personal care and cosmetics packaging, food and beverage packaging, performance films, tape and labels, fibers/nonwovens, photographic and optical film, graphic arts and general packaging. In 2005, the SP segment had sales revenue of $718 million, which represented approximately 10 percent of Eastman’s total sales and 20 percent of Eastman Division’s total sales. The SP segment competes in the market for plastics that meet specific performance criteria, typically determined on an application-by-application basis. Product development in the specialty plastics segment is dependent upon Eastman’s ability to design plastics products that achieve performance characteristics specified by its customers, while providing a better value proposition than alternative materials such as polycarbonate and acrylic. Increases in market share are gained through the development of new applications, substitution of plastic for other materials, and particularly, displacement of other plastic resins in existing applications. The SP segment produces polyesters, specialty copolyesters, plastic sheeting, cellulose esters, and cellulosic plastics. The Company estimates that the market growth for copolyesters, which has historically been high due to the relatively small market size, will continue to be higher than general economic growth due to displacement opportunities. Eastman believes that the cellulosic plastics markets growth will be flat or, at best, equal to the rate of growth of the economy in general. Eastman’s specialty copolyesters, which generally are based on Eastman's market leading supply of cyclohexane dimethanol (quot;CHDMquot;) modified polymers, typically fill a market position between polycarbonates and acrylics. Polycarbonates traditionally have had some superior performance characteristics, while acrylics have been less expensive. Specialty copolyesters combine superior performance with competitive pricing and are being substituted for both polycarbonates and acrylics based on their relative performance and pricing. The SP segment also includes cellulosic plastics, which has historically been a steady business with strong operating margins for the Company, and includes what Eastman believes is a market-leading position in North American cellulose esters for tape and film products and cellulose plastics for molding applications. Eastman has the ability within its SP segment to modify its polymers and plastics to control and customize their final properties, creating numerous opportunities for new application development, including the expertise to develop new materials and new applications starting from the molecular level in the research laboratory to the final designed application in the customer’s plant. In addition, the SP segment has a long history of manufacturing excellence with strong process improvement programs providing continuing cost reduction. Manufacturing process models and information technology systems support global manufacturing sites and provide monitoring and information transfer capability that speed up the innovation process. 12
  31. 31. • Products The SP segment’s key products are: Engineering and Specialty Polymers Engineering and specialty polymers accounted for approximately 50 percent of the SP segment’s 2005 sales revenue. These polymers include a broad line of polyesters, copolyesters, alloys, cellulose flake, and cellulosic plastics that are sold to a diverse and highly fragmented customer base in numerous market segments on a global basis. Approximately 45 percent of the revenues from engineering and specialty polymers are generated in North America. Sales in all regions are generated through a mix of the Company’s direct sales force and a network of distributors. Engineering and specialty polymers products are sold into three sectors: durable goods (principally components used in appliances); medical goods (disposable medical devices, health care equipment and instruments, and pharmaceutical packaging); and personal care and consumer goods (housewares, cosmetics, eyewear, tools, toys, food and beverage packaging). Engineering and specialty polymers products are heavily specification-driven. The Company works with OEM companies to enable product designers to use polymers for a specified use in their products. Although the average life cycle of many of these products is shrinking over time, the Company works to identify uses for the polymers in products that will have multi-year lives. In working with OEM companies on new consumer product designs, new polymer products are often developed for use in a particular type of end-use product. Specialty Film and Sheet Approximately 30 percent of the SP segment’s 2005 revenue resulted from sales of specialty film and sheet products. The key end-use markets for specialty film and sheet are packaging, in-store fixtures and displays, and building and construction. Direct customers are film and sheet producers, but marketing activities focus downstream through designers, specifiers, OEMs and brand owners in targeted end-use markets. In the packaging market, specialty film and sheet is sold to end-use markets including medical and electronic component trays, shrink label films, general purpose packaging, and multilayer films. Copolyester use in these markets is relatively mature with the exception of shrink label films. Competitive materials in these end-use markets are typically PET polymers, acrylics, polyvinyl chloride (“PVC”) and oriented polystyrene. Eastman’s primary brands for these markets are Eastar and Embrace copolyesters. In the display market, Spectar copolyester is marketed primarily for point of purchase displays including indoor sign and store fixtures. Eastar copolyester is marketed into the graphics market. Copolyester use in these end- use markets is expected to grow above display market rates as a result of new business growth. Competitive materials in these end-use markets are polymethylmethacrylate (“PMMA”) and polycarbonate. The building and construction end-use market continues to be a focus for growth in specialty film and sheet. The Company is seeking a number of new opportunities within this market. The use of copolyester in this market is expected to grow significantly above building and construction market rates due to current low penetration of copolyester into targeted segments. Competitive materials for building and construction are typically PMMA, polycarbonate, and glass. 13
  32. 32. Packaging, Film and Fiber Packaging, film and fiber products, which represented approximately 20 percent of the SP segment’s 2005 revenue, include a range of specialty polymer products for markets such as photographic film, optical film, fibers/nonwovens, and tapes/labels uses. Customers are typically manufacturers of film and fiber products, employing a range of processing technologies, including film melt extrusion, solvent casting, and fiber extrusion. These films and fibers products are further converted to produce value-added products, such as photographic film, adhesive tape or nonwoven articles, which are sold as branded items. Products include cellulose esters, copolyesters, specialty polyesters and concentrates/additives. Sales of products that are used as raw materials in traditional photographic markets continue to be under pressure due to the conversion of traditional photographic technology to digital imaging. SP has work underway in the liquid crystal displays market to offset the impact of this conversion. • Strategy The SP segment is focused on delivering consistent gross margins and reinvesting for consistent growth. Over the past two years, the SP segment has divested certain non-core businesses, shut-down certain non-integrated manufacturing operations, and expanded certain integrated facilities. The Company continues to leverage the advantages of being an integrated polyester manufacturer and will continue to pursue opportunities within the integrated polyester stream. One such opportunity is scaled differentiation, which is the potential for SP to utilize rationalized PET assets to reduce copolyester conversion costs and enhance its ability to market its products against competitive materials. This opportunity is expected to capture the synergies of the Polymers segment's advantaged cost structure and SP segment's ability to develop higher value markets. These synergies should enable SP to reduce costs and expand production, increase the scale necessary to substitute for competitive materials, and focus on targeted growth markets. The SP segment continues to pursue growth by investing in marketing, research and development, and manufacturing to meet the needs of the global marketplace. For example, the segment is completing a capital project to increase copolyester intermediates capacity in order to meet expected growth in global demand. Eastman has a broad portfolio of key monomers that can be combined in various ways to yield a range of polymers with widely varying properties for different applications. Development of proprietary technology is currently underway to enable the SP segment to produce a new family of products that would allow entry into applications that have been beyond the reach of the current portfolio of copolyester products. This new technology is expected to offer a combination of chemical and temperature resistance that should lend itself to a number of new applications where these properties are important. The Company competes in market niches requiring polymers with combinations of clarity, toughness, and chemical resistance. The liquid crystal display market is a new focus of growth for SP. SP segment is investing in the development of copolyester and cellulosic-plastic based product solutions for this high-growth market, with the objective of becoming a strategic raw material supplier for liquid crystal display. The SP segment develops product enhancements in order to respond to specific market needs, and expects this to result in increased market penetration for existing products. Likewise, the introduction of new products will provide access to previously underserved markets. In addition, the SP segment is focusing on global growth by investing resources to provide product solutions to customers in previously underserved regional markets. The SP model of innovation leverages a unique and growing portfolio of cellulosics and specialty copolyesters, such as Cadence, a copolyester for calendared film applications, Embrace copolyester for shrink films, and Eastar and Durastar copolyesters for cosmetic and household applications. The Company is a major supplier of resins to the specialty film and sheet markets. With less than 10 percent of the global specialty film and sheet end-use markets, substantial growth opportunities exist for Eastman. The growth strategy is to penetrate new market segments or geographies and offer a substitute for other materials by providing an improved value proposal or design flexibility that enhances the growth potential of the Company’s customers. 14

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